It's Time to Start Laddering Certificates of Deposit Again!

It’s Time to Start Laddering Certificates of Deposit Again!

By John H. Robinson, Financial Planner, May 20, 2023.

Last week saw an unusual and much-welcomed flattening of the CD yield curve.  For the past 15 months or so since interest rates began rising, short-term CDs (18 months or less) have been paying considerably more than longer term (2–7-year CDs).  This inverted yield curve has appeared in other fixed-income securities markets too, including the treasury and corporate bond markets.

Why has the yield curve been inverted?

Inverted yield curves have historically been rare and short-lived.  Intuitively, it makes sense that investors should be rewarded with higher interest rates in return for tying up their money for a longer term.  The generally accepted reason why short-term bonds have been paying more than long term bonds over the past year has been the prevailing expectation that the Federal Reserve Board’s dramatic rate hikes will reverse soon once the Fed believes it has quelled inflation and reverses course to cut rates again stimulate a flagging U.S. economy.

What happened last week to make rates on longer-term CDs rise?

However, instead of seeing a reversal in short-term rates, last week ushered in a jump in CD rates across all maturities, but especially across the 2–7-year segment.  For the first time since the early 2000s, investors can now get 5% interest or more on CDs ranging across all maturities from 1 month to 7 years.  What makes this action a bit peculiar is that this flattening of the yield curve has not occurred to the same degree in the treasury or corporate bond markets.  My guess is that the CD market yield boost has been driven by regional banks competing for new deposits.  Extending attractive yields for longer maturities seems like a reasonable way to help make those deposits stickier as well (i.e., less prone to leaving the bank for higher yields elsewhere).  

How Should Investors Respond?

Regardless of the reason for the sudden interest rate rise on intermediate to longer-term CDs, I am advising Financial Planning Hawaii clients to jump at the chance to lock in current yields for a longer term.  In a December 2022 FPH Blog post, I specifically recommended extending maturities to make the year at the end of the ladder match the CD yield once the long yield hit 5%.   We have now reached that point. Thus, for clients who may be sitting on cash or have bonds or CDs maturing, I recommend staggering/”laddering” maturities in 6-12 month increments out to five years at 5%.  If rates should happen to rise to 6% I will recommend extending the ladders to 6 years.  If rates rise to 7%, I will recommend 7-year ladders… you get the idea.

Conclusion

While Inflation is no one’s friend, to the extent that the Fed is expected to be successful in its battle to tame inflation, investors who lock in high yields for longer periods of time will be glad they did if/when rates subside.  It has been nearly two decades since consumers were able to earn meaningful interest on the bond portion of the portfolio.  People who are retired or approaching retirement should rejoice at the opportunity to begin to start living off interest again.

John H. Robinson is the owner/founder of Financial Planning Hawaii, Fee-Only Planning Hawaii, and Paraplanning Hawaii.  He is also a co-founder of fintech software-maker Nest Egg Guru.

DISCLOSURES

Securities offered through J.W. Cole Financial, Inc. (JWC) member FINRA/SIPC. Advisory services offered through Financial Planning Hawaii and J.W. Cole Advisors, Inc. (JWCA). Financial Planning Hawaii and JWC/JWCA are unaffiliated entities. 

Fee-only financial planning services are provided through Financial Planning Hawaii, Inc. DBA Fee-Only Planning Hawaii, a separate state of Hawaii Registered Investment Advisory firm. Financial Planning Hawaii does not take custody of client assets nor do its advisers take discretionary authority over client accounts.

The information contained herein is general in nature. Neither Financial Planning Hawaii nor J.W. Cole provides client-specific tax or legal advice. All readers should consult with their tax and/or legal advisors for such guidance in advance of making investment or financial planning decisions with tax or legal implications.